Download Firms in Competitive Markets

Seventh Edition
Principles of
Economics
N. Gregory Mankiw
CHAPTER
14
Firms in
Competitive Markets
In this chapter,
look for the answers to these questions
• What is a perfectly competitive market?
• What is marginal revenue? How is it related to
total and average revenue?
• How does a competitive firm determine the
quantity that maximizes profits?
• When might a competitive firm shut down in the
short run? Exit the market in the long run?
• What does the market supply curve look like in
the short run? In the long run?
Introduction: A Scenario
Three years after graduating, you run your own
business.
You must decide how much to produce, what price
to charge, how many workers to hire, etc.
What factors should affect these decisions?
Your costs (studied in preceding chapter)
We begin by studying the behavior of firms in
perfectly competitive markets.
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Characteristics of Perfect Competition
1. Many buyers and many sellers.
2. The goods offered for sale are largely the same.
3. Firms can freely enter or exit the market.
Because of 1 & 2,
The Revenue of a Competitive Firm
Total revenue (TR)
Average revenue (AR)
Marginal revenue (MR):
ACTIVE LEARNING
1
Calculating TR, AR, MR
Fill in the empty spaces of the table.
Q
P
TR
0
$10
n/a
1
$10
$10
2
$10
3
$10
4
$10
$40
5
$10
$50
AR
MR
$10
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certain product or service or otherwise on a password-protected website for classroom use.
MR = P for a Competitive Firm
A competitive firm can keep increasing its output
without affecting the market price.
So,
Profit Maximization
What Q maximizes the firm’s profit?
To find the answer, “think at the margin.”
If Q increases by one unit,
If MR > MC, then
If MR < MC, then
Profit Maximization
(continued from earlier exercise)
At any Q with
MR > MC,
increasing Q
raises profit.
At any Q with
MR < MC,
reducing Q
raises profit.
Profit MR MC
Q
TR
TC
0
$0
$5
–$5
1
10
9
1
2
20
15
5
3
30
23
7
4
40
33
7
5
50
45
5
∆Profit =
MR – MC
$10 $4
$6
10
6
4
10
8
2
10
10
0
10
12
–2
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certain product or service or otherwise on a password-protected website for classroom use.
MC and the Firm’s Supply Decision
At Qa,
Costs
MC
At Qb,
At Q1,
MR
P1
Q
MC and the Firm’s Supply Decision
If price rises to P2,
then the profitmaximizing quantity
Costs
The MC curve
determines the
firm’s Q at any price.
P1
MC
MR
Hence,
Q1
Q
Shutdown vs. Exit
Shutdown:
Exit:
A key difference:
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certain product or service or otherwise on a password-protected website for classroom use.
A Firm’s Short-run Decision to Shut Down
So, shut down if
Divide both sides by Q:
So, firm’s decision rule is:
A Competitive Firm’s SR Supply Curve
Costs
MC
If P > AVC, then
firm produces Q
where P = MC.
ATC
AVC
If P < AVC, then
firm shuts down
(produces Q = 0).
Q
The Irrelevance of Sunk Costs
Sunk cost:
Sunk costs should be irrelevant to decisions;
you must pay them regardless of your choice.
FC is a sunk cost: The firm must pay its fixed
costs whether it produces or shuts down.
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certain product or service or otherwise on a password-protected website for classroom use.
A Firm’s Long-Run Decision to Exit
So,
Divide both sides by Q to write the firm’s
decision rule as:
A New Firm’s Decision to Enter Market
In the long run, a new firm will enter the market if
it is profitable to do so:
Divide both sides by Q to express the firm’s
entry decision as:
The Competitive Firm’s Supply Curve
Costs
MC
LRATC
Q
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certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING
2
Identifying a firm’s profit
Determine
this firm’s
total profit.
Identify the
area on the
graph that
represents
the firm’s
profit.
A competitive firm
Costs, P
MC
P = $10
MR
ATC
$6
Q
50
ACTIVE LEARNING
3
Identifying a firm’s loss
Determine
this firm’s
total loss,
assuming
AVC < $3.
Identify the
area on the
graph that
represents
the firm’s
loss.
A competitive firm
Costs, P
MC
ATC
$5
P = $3
MR
30
Q
Market Supply: Assumptions
1) All existing firms and potential entrants
2) Each firm’s costs
3) The number of firms in the market is
___________ in the short run
due to
___________ in the long run
due to
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certain product or service or otherwise on a password-protected website for classroom use.
The SR Market Supply Curve
As long as P ≥ AVC, each firm will produce its
profit-maximizing quantity
Recall from Chapter 4:
At each price, the market quantity supplied is
the sum of quantities supplied by all firms.
The SR Market Supply Curve
Example: 1000 identical firms
At each P, market Qs = 1000 x (one firm’s Qs)
One firm
MC
P
P
Market
S
AVC
P1
P1
10
Q
(firm)
Q
(market)
10,000
Entry & Exit in the Long Run
In the LR, the number of firms can change due
to entry & exit.
If existing firms earn positive economic profit,
If existing firms incur losses,
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certain product or service or otherwise on a password-protected website for classroom use.
The Zero-Profit Condition
Long-run equilibrium:
Since firms produce where
the zero-profit condition is
Recall that MC intersects ATC at minimum ATC.
Hence, in the long run,
Why Do Firms Stay in Business
if Profit = 0?
Recall, economic profit is revenue minus all
costs,
In the zero-profit equilibrium,
The LR Market Supply Curve
In the long run,
the typical firm
earns zero profit.
P
P=
min.
ATC
One firm
MC
P
Market
LRATC
Q
(firm)
Q
(market)
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certain product or service or otherwise on a password-protected website for classroom use.
SR & LR Effects of an Increase in Demand
P
One firm
Market
P
MC
S1
ATC
P1
P1
Q
(firm)
A
long-run
supply
D1
Q1
Q
(market)
Why the LR Supply Curve Might Slope Upward
The LR market supply curve is horizontal if
1) all firms have identical costs, and
2) costs do not change as other firms enter or
exit the market.
If either of these assumptions is not true,
then LR supply curve slopes upward.
1) Firms Have Different Costs
As P rises, firms with lower costs enter the market
before those with higher costs.
Hence, LR market supply curve slopes upward.
At any P,
For the marginal firm,
For lower-cost firms,
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certain product or service or otherwise on a password-protected website for classroom use.
2) Costs Rise as Firms Enter the Market
In some industries,
The entry of new firms
Hence, an increase in P is required to increase
the market quantity supplied, so the supply
curve is upward-sloping.
CONCLUSION:
The Efficiency of a Competitive Market
Profit-maximization:
Perfect competition:
So, in the competitive eq’m:
Recall, MC is cost of producing the marginal unit.
P is value to buyers of the marginal unit.
So,
In the next chapter, monopoly: pricing and
production decisions, deadweight loss, regulation.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website for classroom use.